Tag: Foreign Direct Investment

One of the major issues that gained attention after the 2007 and 2009 financial crisis due to Wall Street movement was the unduly high compensation being paid to executives of financial institutions even when the corporations were in a state of collapse. This movement against the executive remuneration gained momentum throughout the world. In U.S and many other countries there was a lot of hue and cry about excessive compensation being paid to top executives. Even though in India the situation regarding excessive executive remuneration has not reached alarming levels yet this issue needs to be taken seriously at this stage itself. If not given proper attention then it is not long enough when this problem would be quite glaring in India too.

Many recent corporate frauds such as Satyam fraud, Kingfisher’s fraud and many others have brought into light the dark side of Indian corporate governance practices. In almost all these frauds the executives were drawing a huge salary from the company at the expense of other stakeholders of the company be it shareholders or creditors etc.They used tricks to defraud the investors as well as creditors. Thus, this issue needs adequate attention else it would lead to more such frauds.

Various studies on remuneration schemes of executives in Indian Companies have reflected majorly 3 issues:

1. The remuneration is not strictly based on performance. The highest paid executives are usually not from the best performing companies and many a times even when the value of shares is declining constantly there is no major effect on the remuneration of top executives.
2. There is a huge gap in the compensation level of executives and median employees. The supports for high remuneration state that this is due to the dearth of talent at the top level but even then such a glaring difference in the basic pay as well as in the % increase in pay as compared to median employees is not justified.
3. Also, the studies have found that the promoter CEOs are paid much more in comparison to Non promoter CEOs.

In this paper I would basically study the reasons behind the above findings and would majorly focus on efficiency of current regime in curbing the same and also the role of other interested entities which can serve as a control mechanism on executive remuneration.

For this purpose firstly, analyze the context of executive remuneration and the issues associated with it wherein will focus on agency problem and also the role of ownership structure in enhancing the problem. Then would annalyse the efficacy of checks provided by the current regime on Executive remuneration i.e. Shareholders say on pay, Remuneration committee and linking Remuneration to performance. Lastly, examine the role of Institutional investors as a control mechanism against executive remuneration.

Meaning of Remuneration

Remuneration has been described in section 2(78) of the Companies Act 2013.As per this definition any payment in the form of money or its equivalent would be counted as remuneration. Perquisites would also be included in determining total remuneration. Perquisites in this case are those as defined under the Income tax Act, 1961.

Remuneration can be paid in various forms like cash, medical benefits, retirement benefits, share options, shares, sitting fee and perks and allowances like contribution to provident fund, rent free accommodation, travelling expenses, car etc. It is usually a combination of various forms. Certain perquisites and compensations are explicitly exempted from being counted as a part of remuneration

Role of Executive Remuneration

The role of executive remuneration is to attract and retain top talent at executive position and incentivize them in the way that they work for the benefit of the company while furthering the objective of the company and increasing the value of the firm.

Interplay Between Fixed and Variable Component

The role of fixed component is to fulfill the immediate needs of the employees. All types of companies are open to certain sector specific risks and fixed component reduces the effect of this risk by assuring certain determined amount of income.

On the other hand, variable component can be used to align the interest of executives to the interest of company. For example, if the executives are provided with certain number of shares as a part of remuneration then better performance would lead to increase in the share value of the company and would also increase executive’s compensation.

If the executives receive just fixed remuneration with no variable component then instead of working as incentive, it would actually dilute its effect and if the compensation would include only variable component then this would also frustrate the employee.

Thus, there must be combination of fixed as well as variable component wherein the fixed component work as an incentive to work and the variable component makes sure that the work is done in the interest of the company. Also, it is necessary that there must be interaction between various forms of compensation and the remuneration scheme must be arranged in a way that it is incentive based.

The income from capital gains is not an income which accrues or arises from day-to-day during a specific period but it arises at fixed point of time, namely, on the date of the transfer of a capital asset. Specifically, the income from capital gains is the amount by which the sale price of a capital asset, net of any expense incurred in connection with the sale of the asset, exceeds the acquisition cost of the capital asset. The taxation of capital gains is justified by the taxation policy and law on the premise that capital gains increases the ‘ability to pay’ capacity of the person receiving such a gain.

The provisions related to taxation of capital gains were first introduced in 1947 and then in 1956 and then said section 12B in Income tax Act, 1922 was retained as such in the relevant provisions in Income tax Act, 1961.

Charging sections – Sections 45, 46 and 46A

The charging section explains the subject matter of taxation. Thus, there is one charging section for each head of income for salaries, income from house property, business income and income from other sources. However, for capital gains, there are three independent and separate charging sections:

(i) Section 45: Capital gains

(ii) Section 46: Capital gains on distribution of assets by companies in liquidation

(iii) Section 46A: Capital gains on purchase by company of its own shares or other securities

Section 45 is the general provision while sections 46 and 46A are special provisions.

Incomes to be taxed under the head, ‘Capital Gains’

Thus, the following incomes are taxable as ‘capital gains’:

The situs/location of capital asset matters only for non-resident assessees and not to others. In the cases of Non-resident assessees, if capital asset located outside India is transferred outside India and sale proceeds are received outside India, no taxability to capital gains arises in view of section 5 of the Act. Such assessees will be liable to be taxed under section 9(1) (i) in respect of capital gains accruing or arising “through the transfer of any capital asset situate in India”.

Important Definitions in capital gains

Meaning of Transfer [Section 2(47)]

“Transfer”, in relation to a capital asset, includes:

(i) Sale, exchange or relinquishment of the asset;

(ii) Extinguishment of any rights in relation to a capital asset;

(iii) Compulsory acquisition of an asset;

(iv) Conversion of capital asset into stock-in-trade;

(v) Maturity or redemption of a zero coupon bond;

(vi) Allowing possession of immovable properties to the buyer in part performance of the contract;

(vii) Any transaction which has the effect of transferring an (or enabling the enjoyment of) immovable property; or

(viii) Disposing of or parting with an asset or any interest therein or creating any interest in any asset in any manner whatsoever.

Transactions which are not regarded as transfer [Section 47]

Following transactions shall not be regarded as transfer (subject to certain condition). Hence, following transaction shall not be charged to capital gains:

Full Value of Consideration

Full value of consideration is the consideration received or receivable by the transferor in lieu of assets, which he has transferred. Such consideration may be received in cash or in kind. If it is received in kind, then fair market value (‘FMV’) of such assets shall be taken as full value of consideration.

However, in the following cases “full value of the consideration” shall be determined on notional basis as per the relevant provisions of the Income-tax Act, 1961:

Cost of Acquisition

Cost of acquisition of an asset is the amount for which it was originally acquired by the assessee. It includes expenses of capital nature incurred in connection with such purchase or for completing the title of the property.

However, in cases given below, cost of acquisition shall be computed on notional basis:

* Terminal Depreciation/Balancing Charge:

1. a) Balancing Charge = Sales Consideration – WDV of the depreciable asset
2. b) Terminal Depreciation = WDV – Sales Consideration

Demat System (short for Dematerialization system) refers to the process of converting physical share certificates into electronic form, enabling investors to hold and trade shares digitally through a dematerialized account. Introduced in India in 1996, the dematerialization process revolutionized the stock market by eliminating the need for physical certificates, streamlining the trading process, and making securities transactions safer, faster, and more efficient. The demat system is managed by depositories such as the National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL), which function under the regulation of the Securities and Exchange Board of India (SEBI).

Key Features of the Demat System

• Electronic Form of Securities:

In the demat system, shares, bonds, debentures, and other securities are held in electronic form, eliminating the need for physical certificates. This offers ease of access and ensures that investors can quickly buy, sell, and transfer securities.

• Demat Account:

Similar to a bank account for money, a demat account is an electronic account where securities are stored. Each investor must open a demat account with a Depository Participant (DP), such as a bank, brokerage firm, or financial institution. The DP acts as an intermediary between the investor and the depository (NSDL or CDSL).

• Speed and Efficiency:

Dematerialization process allows for faster trading and settlement of securities. Before dematerialization, the physical transfer of shares took weeks or even months, involving paperwork and delays. Now, transactions are completed in a few days, with real-time updates.

• Safety and Security:

Holding securities in dematerialized form reduces the risk of theft, loss, forgery, and damage associated with physical certificates. The electronic form ensures greater transparency, and investors can track their holdings online through their demat account.

• No Stamp Duty:

No stamp duty is charged on the transfer of dematerialized securities, reducing transaction costs for investors.

• Nomination Facility:

Investors can assign a nominee to their demat account, ensuring that in the event of the account holder’s death, the securities are smoothly transferred to the designated individual.

• Multiple Securities in One Account:

In a demat account, an investor can hold various types of securities, such as shares, bonds, mutual funds, and government securities, in a single account, which offers greater convenience.

Process of Dematerialization:

Dematerialization is the process of converting physical share certificates into electronic form.

1. Opening a Demat Account:

An investor must first open a demat account with a Depository Participant (DP) by filling out an account opening form and submitting the required Know Your Customer (KYC) documents such as proof of identity, proof of address, and a PAN card.

DP provides the investor with a unique Beneficiary Owner Identification (BO ID) number, which is used to identify the account holder in all transactions.

2. Submission of Physical Certificates:

   • After opening a demat account, the investor submits the physical share certificates they wish to dematerialize to the DP along with a Dematerialization Request Form (DRF).
   • The DRF includes details such as the company’s name, the number of shares, and the certificate numbers.

3. Verification and Approval:

   • The DP sends the physical certificates to the relevant company’s Registrar and Transfer Agent (RTA) for verification.
   • Once verified, the RTA approves the dematerialization request, and the physical certificates are canceled.

4. Credit to the Demat Account:

   • After the RTA’s approval, the depository (NSDL or CDSL) credits the corresponding number of shares to the investor’s demat account.
   • The investor receives a notification confirming that the shares have been successfully dematerialized and credited to their account.

5. Trading of Dematerialized Securities:

After dematerialization, the shares can be bought, sold, and transferred electronically through the stock exchanges. Investors can monitor their holdings and transactions online, with settlement occurring in a shorter time frame (T+2 days, where T is the trading day).

Advantages of the Demat System:

• Elimination of Physical Risks:

In the physical form, share certificates were vulnerable to theft, forgery, loss, and damage. The demat system eliminates these risks by holding securities electronically, ensuring safety and security.

• Reduction in Paperwork:

Demat system removes the need for paperwork related to the issuance, transfer, and maintenance of share certificates. This reduces administrative burdens and streamlines the entire process for companies and investors alike.

• Faster Settlement of Trades:

In the pre-demat era, transferring shares involved a lengthy process of physical delivery, verification, and approval, taking several weeks. Now, trades are settled electronically within two days (T+2 settlement), ensuring faster and more efficient transactions.

• Lower Transaction Costs:

By eliminating physical transfers, the demat system reduces costs associated with paperwork, stamp duties, courier charges, and handling fees. Investors benefit from lower transaction costs, making trading more cost-effective.

• Enhanced Liquidity:

Dematerialization has enhanced liquidity in the stock market. Shares held in electronic form can be quickly and easily traded, increasing market efficiency and providing investors with greater flexibility.

• Access to a Broader Range of Securities:

Through a demat account, investors can hold a variety of securities, such as equity shares, bonds, debentures, government securities, mutual funds, and exchange-traded funds (ETFs), all in one place, offering convenience and diversification.

• Transparency and Monitoring:

Investors can easily monitor their holdings, transactions, and portfolio through online access to their demat account. Real-time updates ensure transparency in the management of securities.

• Simplified Pledging of Securities:

Securities held in a demat account can be pledged for loans, offering liquidity to investors. The dematerialized form makes it easier to pledge shares with financial institutions for credit or loan purposes.

Disadvantages of the Demat System:

• Technological Dependency:

Demat system relies on technology, and any system failures or glitches can disrupt trading and access to accounts. Cybersecurity threats and hacking risks are also present in the digital environment.

• Charges and Fees:

While the demat system reduces some costs, investors must pay account maintenance fees, transaction charges, and other service fees to the DP. These charges can add up over time, especially for small investors.

• Loss of Paper Certificates:

Some investors may still prefer holding physical certificates for sentimental reasons or for tangible proof of ownership. The transition to a demat system eliminates the physical representation of ownership.

• Fraud Risks:

Although the Demat system reduces physical fraud risks, it is not immune to other types of fraud, such as unauthorized access to demat accounts, hacking, or insider fraud.

Legal Framework for the Demat System in India

• Depositories Act, 1996:

This act provides the legal framework for the establishment of depositories and facilitates the dematerialization of securities.

• SEBI (Depositories and Participants) Regulations, 1996:

These regulations lay down the rules for the functioning of depositories and DPs.

• SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015:

Companies listed on stock exchanges must ensure that their securities are available for trading in dematerialized form.

Understanding your roles and responsibilities should be your first task when appointed. The board of directors is appointed to act on behalf of the shareholders to run the day to day affairs of the business. The board are directly accountable to the shareholders and each year the company will hold an annual general meeting (AGM) at which the directors must provide a report to shareholders on the performance of the company, what its future plans and strategies are and also submit themselves for re-election to the board.

The objects of the company are defined in the Memorandum of Association and regulations are laid out in the Articles of Association.

The board of directors’ key purpose is to ensure the company’s prosperity by collectively directing the company’s affairs, whilst meeting the appropriate interests of its shareholders and stakeholders. In addition to business and financial issues, boards of directors must deal with challenges and issues relating to corporate governance, corporate social responsibility and corporate ethics.

It is important that board meetings are held periodically so that directors can discharge their responsibility to control the company’s overall situation, strategy and policy, and to monitor the exercise of any delegated authority, and so that individual directors can report on their particular areas of responsibility.

Every meeting must have a chair, whose duties are to ensure that the meeting is conducted in such a way that the business for which it was convened is properly attended to, and that all those entitled to may express their views and that the decisions taken by the meeting adequately reflect the views of the meeting as a whole. The chair will also very often decide upon the agenda and might sign off the minutes on his or her own authority.

Individual directors have only those powers which have been given to them by the board. Such authority need not be specific or in writing and may be inferred from past practice. However, the board as a whole remains responsible for actions carried out by its authority and it should therefore ensure that executive authority is only granted to appropriate persons and that adequate reporting systems enable it to maintain overall control.

The chairman of the board is often seen as the spokesperson for the board and the company.

Appointment of directors

The ultimate control as to the composition of the board of directors rests with the shareholders, who can always appoint, and more importantly, sometimes dismiss a director. The shareholders can also fix the minimum and maximum number of directors. However, the board can usually appoint (but not dismiss) a director to his office as well. A director may be dismissed from office by a majority vote of the shareholders, provided that a special procedure is followed. The procedure is complex, and legal advice will always be required.

Roles of the board of directors

The roles of the board of directors include:

Establish vision, mission and values

• Determine the company’s vision and mission to guide and set the pace for its current operations and future development.
• Determine the values to be promoted throughout the company.
• Determine and review company goals.
• Determine company policies

Set strategy and structure

• Review and evaluate present and future opportunities, threats and risks in the external environment and current and future strengths, weaknesses and risks relating to the company.
• Determine strategic options, select those to be pursued, and decide the means to implement and support them.
• Determine the business strategies and plans that underpin the corporate strategy.
• Ensure that the company’s organizational structure and capability are appropriate for implementing the chosen strategies.
• PEST and SWOT analyses
• Determining strategic options
• Strategies and plans

Delegate to management

• Delegate authority to management, and monitor and evaluate the implementation of policies, strategies and business plans.
• Determine monitoring criteria to be used by the board.
• Ensure that internal controls are effective.
• Communicate with senior management.

Exercise accountability to shareholders and be responsible to relevant stakeholders

• Ensure that communications both to and from shareholders and relevant stakeholders are effective.
• Understand and take into account the interests of shareholders and relevant stakeholders.
• Monitor relations with shareholders and relevant stakeholders by gathering and evaluation of appropriate information.
• Promote the goodwill and support of shareholders and relevant stakeholders.

Responsibilities of directors

Directors look after the affairs of the company, and are in a position of trust. They might abuse their position in order to profit at the expense of their company, and, therefore, at the expense of the shareholders of the company.

Consequently, the law imposes a number of duties, burdens and responsibilities upon directors, to prevent abuse. Much of company law can be seen as a balance between allowing directors to manage the company’s business so as to make a profit, and preventing them from abusing this freedom.

Directors are responsible for ensuring that proper books of account are kept.

In some circumstances, a director can be required to help pay the debts of his company, even though it is a separate legal person. For example, directors of a company who try to ‘trade out of difficulty’ and fail may be found guilty of ‘wrongful trading’ and can be made personally liable. Directors are particularly vulnerable if they have acted in a way which benefits themselves.

• The directors must always exercise their powers for a ‘proper purpose’ – that is, in furtherance of the reason for which they were given those powers by the shareholders.
• Directors must act in good faith in what they honestly believe to be the best interests of the company, and not for any collateral purpose. This means that, particularly in the event of a conflict of interest between the company’s interests and their own, the directors must always favour the company.
• Directors must act with due skill and care.
• Directors must consider the interests of employees of the company.

Calling a directors’ meeting

A director, or the secretary at the request of a director, may call a directors’ meeting. A secretary may not call a meeting unless requested to do so by a director or the directors. Each director must be given reasonable notice of the meeting, stating its date, time and place. Commonly, seven days is given but what is ‘reasonable’ depends in the last resort on the circumstances

Non-executive directors

Legally speaking, there is no distinction between an executive and non-executive director. Yet there is inescapably a sense that the non-executive’s role can be seen as balancing that of the executive director, so as to ensure the board as a whole functions effectively. Where the executive director has an intimate knowledge of the company, the non-executive director may be expected to have a wider perspective of the world at large.

The chairman of the board

The articles usually provide for the election of a chairman of the board. They empower the directors to appoint one of their own number as chairman and to determine the period for which he is to hold office. If no chairman is elected, or the elected chairman is not present within five minutes of the time fixed for the meeting or is unwilling to preside, those directors in attendance may usually elect one of their number as chairman of the meeting.

The chairman will usually have a second or casting vote in the case of equality of votes. Unless the articles confer such a vote upon him, however, a chairman has no casting vote merely by virtue of his office.

Since the chairman’s position is of great importance, it is vital that his election is clearly in accordance with any special procedure laid down by the articles and that it is unambiguously minuted; this is especially important to avoid disputes as to his period in office. Usually there is no special procedure for resignation. As for removal, articles usually empower the board to remove the chairman from office at any time. Proper and clear minutes are important in order to avoid disputes.

Role of the chairman

The chairman’s role includes managing the board’s business and acting as its facilitator and guide. This can include:

• Determining board composition and organisation;
• Clarifying board and management responsibilities;
• Planning and managing board and board committee meetings;
• Developing the effectiveness of the board.

Find out more about director development and training.

Shadow directors

In many circumstances, the law applies not only to a director, but to a ‘shadow director’. A shadow director is a person in accordance with whose directions or instructions the directors of a company are accustomed to act. Under this definition, it is possible that a director, or the whole board, of a holding company, and the holding company itself, could be treated as a shadow director of a subsidiary.

Professional advisers giving advice in their professional capacity are specifically excluded from the definition of a shadow director in the companies legislation.

Dividends are a portion of a company’s profits distributed to its shareholders as a reward for their investment in the company. The decision to declare dividends is made by the board of directors, but the process is governed by several legal and regulatory frameworks to ensure fairness, transparency, and adherence to corporate governance norms. In India, the declaration and distribution of dividends are primarily regulated by the Companies Act, 2013, along with rules set forth by the Securities and Exchange Board of India (SEBI) for listed companies.

Meaning and Types of Dividends:

Dividend is a return on investment for shareholders, paid from the profits of the company. It can be issued in several forms:

1. Interim Dividend:

Declared by the board of directors during the financial year before the finalization of accounts. This is typically paid out of the profits earned during the current financial year.

2. Final Dividend:

Declared at the company’s Annual General Meeting (AGM) after the financial year has ended and the accounts are finalized. It is recommended by the board but requires shareholder approval.

3. Special Dividend:

Paid in extraordinary circumstances when the company has a significant surplus of profits or cash. This dividend is not a regular payout.

4. Stock Dividend (Bonus Shares):

Instead of cash, the company issues additional shares to its shareholders in proportion to their existing holdings.

5. Scrip Dividend:

The company issues a promissory note to the shareholders, promising to pay the dividend at a later date, which can be considered a form of deferred payment.

Legal Provisions for Declaration of Dividends Under the Companies Act, 2013

The provisions governing the declaration and distribution of dividends are laid down under Section 123 of the Companies Act, 2013, along with the Companies (Declaration and Payment of Dividend) Rules, 2014.

1. Declaration of Dividend

Profit Requirement:

Dividends can only be declared out of the following:

• • Current year profits after providing for depreciation and any necessary reserves.
  • Previous year profits that have not been transferred to reserves or used for dividends earlier.
  • Government Grant: If a company has received government assistance in certain situations, this may be considered in specific circumstances.

Free Reserves:

If the company’s profits are insufficient, it can declare a dividend out of its accumulated profits or free reserves, provided that:

• • The rate of dividend does not exceed the average rate of dividends declared in the preceding three financial years.

  • The amount withdrawn from the reserves is not more than 10% of the paid-up share capital and free reserves of the company.

Interim Dividend:

The board may declare an interim dividend out of profits available after providing for depreciation. However, if the company suffers a loss up to the quarter immediately preceding the interim dividend declaration, the interim dividend cannot be declared at a rate higher than the average dividend declared during the preceding three financial years.

2. Depreciation

• The company must provide for depreciation in accordance with Schedule II of the Companies Act, 2013 before declaring dividends.
• Any dividend declared without taking into account depreciation can be considered illegal and can attract penalties for the company and its directors.

3. Transfer to Reserves

Before declaring dividends, companies are required to transfer a certain percentage of their profits to reserves, as per the discretion of the board of directors. However, the Companies Act no longer mandates a specific minimum percentage to be transferred.

4. Dividend on Preference Shares

Preference shareholders are entitled to dividends at a fixed rate before any dividends are declared for equity shareholders. The dividend for preference shares must be paid first, and any arrears of preference dividends must be cleared if applicable.

5. Payment in Cash

Dividends must be paid in cash, cheque, or electronic means. A company cannot declare dividends in kind (i.e., through assets). However, stock dividends (bonus shares) are permissible.

6. Dividend Distribution Tax (DDT)

Finance Act, 2020, abolished the Dividend Distribution Tax (DDT). Earlier, companies were required to pay tax on the dividends distributed. Now, shareholders are liable to pay tax on the dividends they receive based on their individual income tax slabs.

7. Timeframe for Payment

Once a dividend is declared at the AGM, the company must pay the dividend to the shareholders within 30 days from the date of declaration. If the company fails to do so, it attracts penalties and interest charges.

8. Unpaid or Unclaimed Dividend

• If a dividend remains unpaid or unclaimed for 30 days from the date of declaration, it must be transferred to a special Unpaid Dividend Account within 7 days of the expiration of the 30-day period.
• If the dividend remains unclaimed for seven years, it must be transferred to the Investor Education and Protection Fund (IEPF).

Process for Dividend Distribution:

1. Board Meeting:

The process begins with a board meeting where the directors review the financial performance of the company. Based on profitability and liquidity, the board decides whether to recommend a dividend to the shareholders.

2. Declaration at AGM:

In the case of a final dividend, the declaration is made at the Annual General Meeting (AGM) of the company. The shareholders must approve the dividend recommended by the board. Without this approval, the company cannot distribute the dividend.

3. Record Date:

Company must set a record date, which is the cut-off date for determining the shareholders who are entitled to receive the dividend. Only those shareholders whose names appear in the company’s register on this date are eligible for the dividend.

4. Payment of Dividend:

Dividend can be paid via cheque, demand draft, or electronic transfer. The payment must be completed within 30 days of the declaration, failing which the company is subject to penalties.

Penalties for Non-Compliance:

Failure to comply with the rules regarding dividend declaration and distribution can result in penalties for both the company and its officers.

• Imprisonment and Fines:

Under Section 127 of the Companies Act, if the company fails to pay the dividend within 30 days of its declaration, every director who is knowingly a party to this default may be punished with imprisonment for up to 2 years and a fine of ₹1,000 for each day the default continues.

• Interest:

In case of a delayed payment, the company is liable to pay interest on the unpaid dividend at the rate of 18% per annum until the payment is made.